The Triumph of Madness

Historic Misjudgments in Hindsight

Viewing the past through the lens of history is unfair to the participants. Missteps are too obvious. Failures are too abundant. Vanities are too absurd. The benefit of hindsight often renders the participants mere imbeciles on parade.

Were George Donner and his brother Jacob naïve fools when they led their traveling party into the Sierra Nevada in late fall? Perhaps. Particularly when they resorted to munching on each other to survive the relentless blizzard.

Certainly, Custer and the Donner brothers were doing the best they could with the information available to them. The decisions they made must have seemed reasoned and calculated at the time. But what they couldn’t see – until it was too late to turn back – was that with each decision, they unwittingly took another step closer to their ultimate demise.

Still they were human just like we are human… no smarter, no dumber. We are not here to ridicule them; but rather, to learn from them.

A Good Man in a Bad Trade

Rudolf von Havenstein had been president of the Reichsbank – the German central bank – since 1908. He knew the workings of central bank debt issuance better than anyone. He was good at it.

Thus, when he was called upon by history to deliver a miracle for the Deutches Reich in the aftermath of WWI, he knew exactly what to do. He would deliver monetary stimulus.  In fact, he had already been at it for several years.

On August 4, 1914, at the start of the war, the gold mark – or gold-backed Reichmark – became the unbacked paper mark. With gold out of the picture, the money supply could be expanded to meet the endless demands of war.

To this end, von Havenstein took public debt from 5.2 billion marks in 1914 to 105.3 billion marks in 1918. Over this time, he increased the quantity of marks from 5.9 billion to 32.9 billion. German wholesale prices rose 115 percent.

By the war’s end, Germany’s economy was in shambles. Industrial production in 1920 had slipped to just 61 percent of the level seen in 1913. With a weak economy, and under the crushing weight of debt, it was time for von Havenstein to really get to work.

In truth, he didn’t have much of a choice. The limits of fiscal and monetary prudence had been crossed when the gold-mark was replaced with the paper-mark. Reversing course now would have brought an immediate economic collapse and societal discord. What happened next?

The Triumph of Madness

Our friend Bill Bonner, as recently revealed in his Daily Diary, will tell you what happened next:

“The authorities had financed the war by printing money.  Now, they figured they could print their way out of the post-war depression… the decision seemed like the right one at the time. It prevented an immediate crisis – with mass unemployment and political upheaval.

“Von Havenstein knew it would cause inflation, but he considered it the lesser of two evils.  He also seemed to think that the inflation would be moderate – as it had been during the war – and that it would reduce the crushing weight of Germany’s war debt. One little step led to another.  And five years later, when von Havenstein died, the central bank of Germany had printed some 500 quintillion marks. This hyperinflation of the money supply caused a hyper deflation in the value of the mark.  One U.S. dollar was worth 4.2 trillion marks by December 1923. Yet for all the ‘money’ held by Germans, they were destitute.  The economy had caved in.  Violent mobs were out in the streets.  A decade later, the Nazis rose to power, the Reichstag burned, and 60 million died in WWII. But who could have seen that coming?”

Wholesale and consumer prices

- Click to enlarge

The evolution of prices, exchange rates, wages and unemployment during the Weimar Republic’s hyperinflation episode (adapted from Constantino Bresciani-Turroni). Initially, the ill effects of the Reichsbank’s money supply inflation seemed to be limited; as real wages declined, unemployment actually fell to record lows – a crack-up boom was underway.  Eventually the German government introduced mandatory wage indexing in order to mitigate the growing plight of wage earners. Upon this unemployment immediately soared, moving from record lows to record highs within just two years. At the same time the decline in the paper-mark’s purchasing power and external value accelerated until the currency for all practical purposes ceased to function as a viable medium of exchange. The medium-term political repercussions of this economic catastrophe would soon engulf the whole world. [PT]

1. President Nixon’s ‘temporary’ suspension of the Bretton Woods Agreement in 1971 cuts the link between the dollar and gold.
2. Alan Greenspan establishes the Greenspan put following the Black Monday crash of October 19, 1987 – gifting the mother of all moral hazards to Wall Street gamblers.
3. The taxpayer funded bailout of the Savings & Loans industry in 1989 – presaging the 2007 subprime mortgage crisis.
4. The Fed’s bailout of Long-Term Capital Management in 1998 – inadvertently supplying excess gas to an already overinflated dot com bubble.
5. Greenspan’s easy money policies in the early 2000s following the bursting of the dot com bubble – inflating residential real estate prices.
6. Hank Paulson’s 2008-09 TARP bailout bazookas – ‘heads I win, tails you lose’ socializing Wall Street losses to taxpayers.
7. Ben Bernanke’s courage to act money printing via quantitative easing (QE) and zero interest rate policy (ZIRP) from 2008 to 2014 – the origins of today’s everything bubble.
8. The Powell pivot and abrupt end of monetary policy normalization in 2019 – adding fuel to the fire and sustaining the everything bubble no matter what.
9. Repo madness program of 2019 thru the present – breakdown of the overnight funding market and the indefinite application of daily liquidity conjured out of thin air by the Fed.
10. The Fed’s ‘Not QE’ reserve management program of 2019 thru the present – Rudolf von Havenstein style money printing to buy U.S. Treasuries, fund trillion dollar deficits, and keep the lights on in Washington at all costs.

What happens next? Debts will be paid in full. The dollar will go up in smoke.  And step by step, madness of the kind only abstract thinking can forecast will triumph.

A 100 trillion marks banknote issued in February 1924 (note: the German term for “trillion” is Billionen).

In order to restore economic confidence, the Reichsbank replaced the paper-mark in mid November 1923 with a transitional currency, the so-called “Rentenmark”, at a rate of 1 Rentenmark for 1 trillion paper marks. It was yet another fiat currency, pretend-backed by agricultural and business real estate, but the limit placed on its issuance did do the trick. For a while all three German currencies (paper mark, gold mark and Rentenmark) existed side-by-side; in August 1924 the Rentenmark was exchanged 1:1 for the new Reichsmark and the old paper mark was phased out. [PT]